Question 11.1: Consider a company with the following financial statements:
Consider a company with the following financial statements:
| Balance Sheet (€ M) Company AAA |
|||||
| 2015 | 2016 | 2015 | 2016 | ||
| Current Assets | Current Liabilities | ||||
| Cash | 1,130 | 1,330 | Accounts Payable | 86 | 102 |
| S.T. Investments | 200 | 250 | Accrued Interest | 4 | 4 |
| Accounts Receivable | 120 | 140 | Other Current Liab. | 230 | 300 |
| Inventory | 180 | 225 | Tot. Current Liab. | 320 | 410 |
| Other Current Assets | 40 | 52 | |||
| Tot. Current Assets | 1,670 | 1,997 | Long Term Liabilities | ||
| Fixed Assets | Notes Payable | 95 | 168 | ||
| PPE | 10,850 | 11,250 | Mortgages | 3,500 | 3,650 |
| Accum. Depreciation | (1,950) | (2,125) | Other L.T. Debt | 1,135 | 1,264 |
| Tot. Fixed Assets | 8,900 | 9,125 | Tot. L.T. Debt | 4,730 | 5,082 |
| Equity | |||||
| Stocks | 5,300 | 5,300 | |||
| Retained Earnings | 220 | 330 | |||
| Tot. Equity | 5,520 | 5,580 | |||
| Tot. Assets | 10,570 | 11,122 | Tot. Liabilities | 10,570 | 11,122 |
| Income statement (€ 000s) Company AAA, 2016 |
|
| Sales . . . |
1,000,000 . . . |
| Cost of sales . . . |
-650,000 |
In order to calculate the operating cycle and cash cycle of the company, the components of the timeline can first be calculated as:
IP=\frac{AI}{\frac{CS}{365} }= \frac{AI}{\frac{CS}{365} }=\frac{\frac{180,000,000+225,000,000}{2} }{\frac{650,000,000}{365} } =114 daysRP=\frac{AR}{\frac{Sales}{365}}=\frac{\frac{120,000,000+140,000,000}{2} }{\frac{1,000,000,000}{365} } =47 days
PP=\frac{AP}{\frac{CS}{365}}=\frac{\frac{86,000,000+102,000,000}{2} }{\frac{650,000,000}{365} } =53 days
Therefore the operating cycle and cash cycle are:
OC=IP+RP=114+47=161 daysCC=OC-PP=16-53=108 days
The management of the operating cycle and cash cycle can be done by directly changing the variables that are more under control of the company. Some of the variables involved in fact are not easy to manage in a short time.
So, for example, a company with a very long inventory period can manage the situation by reducing the average amount and age of the inventory in stock. An increase in the inventory turnover in fact may reduce the inventory period and improve financial performance.
On the side of the receivables a company with problems should try to reduce the collection period so to reduce the receivables period in a fairly quick way without losing customers.
On the side of the payables, the opposite obviously holds, and the company should be able to secure contracts with suppliers that allow for a longer payables period in order to improve the situation in terms of inflows and outflows.
For all of the above, a big role is played by the implementation of technology.
Modern management systems can help in obtaining the results at the lowest possible cost for the company, thus improving profitability.
This is true for all aspects of working capital management, and the efficient management of current assets can overall reduce the amount of working capital needed to run the production.